One bad drought could spell disaster for grain farmers, consumers

Wheat stocks are at their lowest ebb since post-World War II and prices are at near record highs. Soybean stocks are likewise moving to below that magic five percent level and corn — well the demand for ethanol speaks for itself.

Low wheat stocks have encouraged investment bankers to dump millions of dollars on the U.S. market in hopes of making a quick profit. The result has been to artificially increase the price of wheat-containing food products and to push the supply of wheat worldwide to alarmingly low levels.

Demand for corn, in hopes of off-setting supply problems that have contributed gas and diesel prices pushing $4 per gallon in some areas of the U.S., is sure to keep corn prices soaring.

And, soybeans, though not as much in the press as corn as a source of biofuels is quietly becoming an oil of choice for easy to produce biodiesel. With diesel prices already nearing $4 per gallon, it is a safe bet biodiesel will get more and more attention as a fossil-fuel alternative.

While high grain prices provide unprecedented opportunities for the production side of agriculture, the business side is precariously balanced between the proverbial rock and hard place. One bad production year could mean disaster for the agriculture infrastructure of the U.S. Or, as one analyst contends, “we are one drought away from disaster.”

High prices are not necessarily a farmer's best friend, says Jimmy Glover, general manager of Glover Milling Company in Bailey, N.C. “A few may make a lot of money, but in the long-run the entire industry will suffer and some people will go out of business,” Glover says.

Georgia Governor Sonny Perdue, himself a former grain dealer and former President of the Southeastern Grain Dealers Association, says these unprecedented high prices (corn, wheat and soybeans all at or near 10-year highs at the same time) put grain dealers in a situation where one bad margin call or one missed hedge can put them out of business.

Farmers, likewise, can literally lose the farm by forward contracting high priced grain, because of drought or any number of production problems, not being able to deliver the contract and having to buy grain at inflated prices.

A number of factors have come together to put the world supply of wheat, and to a lesser degree corn and soybeans, at perilously low supplies. Some of the reasons are weather-related, but some are strictly man-made.

Extreme weather shifts over the past two years have reduced wheat harvest worldwide by nearly 10 percent. High corn prices, fueled by the demand from the ethanol industries in the U.S. and western Europe have correspondingly pushed wheat planting down in what are typically among the highest-yielding wheat producing countries in the world.

The combination of factors has left wheat supplies at their lowest levels since 1973, or since 1940, depending on which analyst is to be believed. Either way, wheat stocks of less than four percent worldwide has prompted stunningly high prices, reportedly as high as $25 per bushel in some markets.

The low wheat stocks and the worldwide focus on finding alternative biofuels has caught the eye of major investors worldwide. As a result huge financial portfolio managers, most notably in the U.S., have dumped billions of dollars in the grain futures market.

While these financial maneuvers marginally impacted the price of soybeans and corn, it has dramatically impacted the cost of wheat.

If corn and soybean stocks take the same path as wheat, whether driven by crop production declines worldwide or by investment brokers, the basis for over 70 percent of the food products in the United States will be directly affected — and not in a positive way.

The real losers in this high stakes game of supply and demand are consumers.

Analysts are already simulating what would happen if a drought hit the Corn Belt. Bruce Babcock, an agricultural economist at Iowa State University, estimates that corn could reach $8 a bushel from $5.65 as of early March.

Corn prices affect the cost of gas, as more states go to 10 percent ethanol blends to meet clean air standards. Corn prices affect the price of beef, pork, poultry and other meat products. A $6 a pound sirloin steak and $4 gallon of milk are bargains, compared to the price should corn sell for long periods of time at $8 per bushel.

Wheat prices have already sent bread prices up, and with wheat selling for $10-12 per bushel, bakers simply can't absorb the extra price. U.S. consumers will likely pay the higher prices for meat, but not for bread.

In the Southeast in 2007, drought decimated the 25-year high acreage of corn planted. Despite huge acreage increases, corn yields across the region were down from 2006 levels. Fortunately, the Midwest — America's Corn Belt — faired much better, and the Southeastern corn failure was just a minor blip on the overall corn radar screen.

Had that same level of drought hit the Midwest, not to mention other top corn-producing areas of the world, the result would have been catastrophic.

Since 1971, in the United States, droughts or floods have wiped out 21-29 percent of the Midwest corn crop four times. Dramatic wheat losses, due to spring freezes are even more frequent. Soybean losses to drought, delayed planting and the real threat from Asian soybean rust puts that crop at similar or worse risk.

The risk of drought is higher than normal because of La Nina. The cooling of ocean temperatures associated with La Nina has a drying effect and has been pointed to as the culprit for extended droughts in Africa and to less dryer levels in other parts of the world.

Past drought, freeze and flood-related crop shortages have caused widespread shortages of food. The next disaster would be the first to cause a widespread shortage of fuel as well. That's because ethanol — mostly refined from corn — will make up about 6 percent of the nation's gasoline supply this year, and that's expected to rise to 10% over the next five years. The amount of ethanol used in California gasoline is expected to grow at a faster rate, reaching 10 percent by 2010.

What's driving U.S. grain markets?

Low cost of the U.S. dollar. The United States has historically exported over 40 percent of its wheat crop and over 25 percent of its soybean crop. Low cost of the dollar makes U.S.-grown commodities more attractive to developing markets.

Exports. Overseas demand for U.S. wheat is forecast to hit a 12-year high of 1.2 billion bushels in 2008. Soybean exports are expected to total slightly more than 1 billion bushels — 113 million bushels below the 2007 export record.

Crop failures worldwide. Wheat production in South America, Australia and western Europe has been cut from five to 20 percent in each of the past two growing sesons.

Alternative fuels. U.S. corn farmers are expected to top 90 million acres again in 2008, down slightly from 2007. Corn produced for ethanol is expected to increase 51 percent in 2008, to 3.2 billion bushels.

Historic low supplies. Wheat stocks of 272 million bushels is the lowest since the 1940s and soybean stocks of 160 million bushels is the lowest in the past 35 years. Traditionally, large supplies of peanuts worldwide has reduced the shortage in soybeans for oil, but reduced peanut stocks and high prices reduce the bailout for 2008 and beyond.

Investment money. The potential for high risk, high profit in the commodity industry has attracted investment bankers and high capital portolio managers who have dumped huge amounts of money, especially in the U.S. market.

For the farmer, the high prices have meant correspondingly high prices in fertilizer and other fossil-fuel based production products and equipment. The high prices of grain have not uniformly meant high profits for farmers. Hopefully, a weather friendly 2008 growing and harvesting season will mean good profits for growers and reasonable prices for consumers.